Cash buffer vs. rebalancing

[Willers]

So far (2 1/2 years into RE) we've kept about a year in true cash - MM's and no EWP CD's. We have another two years in sort-of cash - longer terms CD's and iBonds.

We aren't spending nearly what we though we would or the calcs say we can (40%/yr under) so we may let the cash drift up naturally.

I went through 2008/2009 with two incomes. They were both shaky, but we both made it. I understand the psychological benefit of cash in that circumstance. Not sure how I'll react in retirement, but I'll find out at some point...

 

[pb4uski]

I agree. I hate the idea of tying up any significant blob of money in cash where it earns nearly nothing. ....

For many of us, our cash stash is in online savings accounts... mine currently earns 1.8% and my next cash-like item, VMMXX earns 2.1%. Mine is only semi significant... 5% after I have rebalanced and between 2-3% just before I rebalance.

If I could have earned 3.3% in bonds and earned 1.8% in cash the delta is 1.5%... but if my cash averages 3.5% of my portfolio the drag is .05%.

 

[OldShooter]

... Both SAMBX and OOFAX have average credit quality of B.
B = Non-investment grade = junk bonds. Morningstar puts them in lower left quadrant, which is "low credit quality".

Seems to me that junk bond investments are more "investment" type investments than a safe harbor for your cash. Reaching for yield is risky.

@rayvt, you really can't stop with the Morningstar sheet when you are looking at these more sophisticated investments.

First, you said that OOSAX and SAMBX have similar yields. If so, where do you think the Oppenheimer guys are getting that extra 48 basis points? Guaranteed they are not falling out of the sky and the lead manager's dog is not bringing them home every evening. The difference can only come from making riskier/higher yielding investments. And 48bps is a big number in this low yield environment. Don't just stop with the simplistic Morningstar risk grid.

Said another way, both having "B" rated companies in their portfolios does not mean the portfolios have equal risk. Also, these floating rate funds do not usually even hold bonds. They hold bank loans that they have purchased. Where the borrower may and probably does have bonds rated as "junk," the bank loans are senior to the bonds. And, unlike bonds, the bank loans have a floating interest rate based on Prime or on the LIBOR. So interest rate risk is reduced. I'm not going to cover everything about the differences between thes funds and junk bond funds, but I think you get the idea that looking at the Morningstar sheet is not adequate due diligence.

I don't mean to imply that the higher return on this type of fund isn't risker than some of the "cash" alternatives, but you do have to understand that they are a different animal and that research is mandatory.

BTW, if you really want an E-ticket ride, there are leveraged floating rate funds too. Not for me, but they do have a market.

 

[rayvt]

@rayvt, you really can't stop with the Morningstar sheet when you are looking at these more sophisticated investments.

Yup, I agree. That's why I said these are more "investment" investments than safe "dividend/interest" places to stash cash.

And too difficult for me. Stocks are hard enough, and stocks are much more transparent than bonds.

Back to the title of this thread......Rebalancing is far better than keeping a large cash buffer.

 

[nash031]

I typically keep very little cash, and that is usually only in my Roth IRA where I do some play time with individual stocks (currently AAPL and T).


That said, we may pull some equity out when we sell our house. I will likely keep that in cash (it'd be roughly 12% of our total portfolio) until the market heads south for a little bit, say 10-12% at least. I won't try to call the bottom. I'll just try to get a little bit of a discount from where we are. Of course there's no guarantee of that, either, so who the hell knows? I'd probably be better served just to DCA it all in over the course of a year or so.

 

[RobLJ]

I've got a chunk of money from stock rebalancing over the last year that, rather than adding to bond funds, I stashed in a money market fund (or CDs would also be fine). This is largely because I suspect the Fed will continue raising rates for a while, and 2% isn't too far below bond fund yields (not to mention overall bond fund returns as interest rates rise).



I would use it to buy stocks to rebalance rather than the bond funds after a 10-20% correction. I also have a small chunk in a floating-rate fund for smilar reasons (although the yield is twice as much as the MM).
The cash/MM/floating fund is more a function of where I think we are in the rate cycle. I don't mind being wrong on this; it won't kill me or the portfolio.




I still have about 4X the percentage of cash in bond funds, however.

There have been discussions lately about the low yields right now of bond funds and how the Vanguard prime money market is almost matching it for yield, with some people electing to move into VMMXX for the time being. Wondering about this in terms of this "cash bucket" discussion.

 

[pb4uski]

I've got a chunk of money from stock rebalancing over the last year that, rather than adding to bond funds, I stashed in a money market fund (or CDs would also be fine). This is largely because I suspect the Fed will continue raising rates for a while, and 2% isn't too far below bond fund yields (not to mention overall bond fund returns as interest rates rise).



I would use it to buy stocks to rebalance rather than the bond funds after a 10-20% correction. I also have a small chunk in a floating-rate fund for smilar reasons (although the yield is twice as much as the MM).
The cash/MM/floating fund is more a function of where I think we are in the rate cycle. I don't mind being wrong on this; it won't kill me or the portfolio.




I still have about 4X the percentage of cash in bond funds, however.

I'm in a similar spot other than the last two parts (the floating rate fund and a lot of bonds). A few months ago I sold most of my bonds and have the money parked temporarily in VMMXX at 2.1% or so but with no interest rate risk and negligible credit risk. CDs are sometimes tempting but the yield curve is so flat I'm undecided what terms to put the money and 2.1% isn't that much lower. Ditto here.... if I'm wrong it isn't a big deal.

 

[NoMoreJob]

I've been retired for quite a few years. I typically keep 2-3 years of spending needs in reserve. I don't do it because I think it helps my returns but because it helps me sleep at night. It also helps me with income planning for ACA purposes. I have a buffer that will not trigger additional income should a large unexpected medical or other expense arise. If the market tanks as it did in '08-'09 I live on the cash and rebalance fixed income to equities.

 

[sengsational]

That was me. I was like a deer in the headlights.... parallelized by the uncertainty. I stood pat but I could not muster the courage to sell bonds and buy more stocks... if I had I would be much richer today.

Back then I was working and had a secure job so the dough was rolling in every couple weeks. If it happens again, I'm not sure what I will have the courage to do.... I suspect that I would at least stand pat but possibly might buy more stocks.

I know a couple people who were older and retired who bailed from stocks and never bought back in.

That 2008 reflection also describes me.

That's why I wonder if I'll have the guts to continue to rebalance to target when the next crash happens. My protection from having to liquidate equities comes in the form of a 401k guaranteed income fund, and it would last me a somewhat long bear market if I rebalanced, and a very long bear market if I didn't.

 

[RobLJ]

A few random thoughts:


1) The argument that a cash allocation hurts long-term returns does not persuade me, particularly. My goal is not necessarily to maximize long-term gains, so I can leave a huge chunk to the DSs or to charity.

2) This time it may be different. The valuation of US stocks is historically high. And that may work out--or it may turn out like 2001 tech valuations. We shall see.

Taking gains from yuge stock gains and sticking some of those gains in cash could--could, could--turn out in 2-3 years not to be such a sucker strategy. (Yes, yes, yes, market timing.)
And it's always like this ignores the fact that the same argument got blown up in the historic valuations in 2001 for tech/large cap growth stocks.

3) Bonds don't look that attractive, so rather than sticking reaped stock gains in bonds, using MM that are only a point or so less than bond funds while the Fed is tightening, doesn't seem like an idiot strategy. (For now, at least.)


In my case, DW is too young to draw from her retirement funds, so it's all on me for the next 3.5 years (and 6 years before I draw SS). So I've got 3.5 years of cash on my side, and the cash on her side is available for reallocation into stocks if the worst happens and the market does crash.

After she can draw from her retirement accounts and I'm taking SS, then I'll probably up my stock allocation and decrease cash.


So it's all pretty fine-grained based on one's peculiar situation, isn't it?



4. If the goal is to leave the maximum to heirs and charity and you won't run out of money--which is probably the case for many here--poo-pooing cash probably makes sense. That ain't me.

 

[NoMoreJob]

That 2008 reflection also describes me.

That's why I wonder if I'll have the guts to continue to rebalance to target when the next crash happens. My protection from having to liquidate equities comes in the form of a 401k guaranteed income fund, and it would last me a somewhat long bear market if I rebalanced, and a very long bear market if I didn't.

I was 60/40 before the crash and could only bring myself to rebalance to 50/50 during it. I took that as a sign that 50/50 was my real sleep-at-night number and I've remained there since. I think that having a reasonable cash reserve helped give me the 'courage' to re-balance.

 

[indiajust]

Cash is king in a crunch. You cannot allocate into a crunch without cash. That is how Buffett gets his bargains. The cash drags his balance sheet for years or decades. And then it doesn't.

 

[NoMoreJob]

I don't rebalance the cash into my equities but the cash does give me the confidence/comfort to rebalance my fixed income into equities when the market takes a dive. It's tough to take psychology out of investing but this is one way I try to do that.

 

[audreyh1]

I know that the only thing that got me to rebalance and buy stocks at the lowest points in 2008/9 was having a cash buffer to cover near term expenses and sufficient fixed income in the portfolio. My portfolio fixed income got squeezed to the minimum I considered acceptable.

The financial system was in such a crisis, that I didn’t know if I’d be drawing down fixed income over the next 8-10 years before equities finally started to recover. Heck, I thought it likely for equities to continue to go down more over the next year or two. So buying stocks while they were still dropping was very daunting.

 

[audreyh1]

I don't rebalance the cash into my equities but the cash does give me the confidence/comfort to rebalance my fixed income into equities when the market takes a dive. It's tough to take psychology out of investing but this is one way I try to do that.

Well you really can’t take psychology out of investing. You have to choose investing techniques that are compatible your psychology.

 

[UnrealizedPotential]

Cash is king in a crunch. You cannot allocate into a crunch without cash. That is how Buffett gets his bargains. The cash drags his balance sheet for years or decades. And then it doesn't.

Buffett can afford to do that. He can afford to hold large amounts of cash and play the waiting game for years. Most of us need to put our money to work now to support ourselves and reap the stock market gains to keep up with inflation.


I hold some cash, but using it to buy up bargains left and right if a bear market hits is a pipe dream. But yes, I agree with you in that there is a ton of money to be made if one can hold cash and wait for bargains. I just think for the most part, the average investor may not be able to do that on a large enough scale to make much difference to their net worth.

 

[audreyh1]

Buffett can afford to do that. He can afford to hold large amounts of cash and play the waiting game for years. Most of us need to put our money to work now to support ourselves and reap the stock market gains to keep up with inflation.

But we individuals don’t have to have ALL our assets in equities to beat inflation. It can be less than 50% with rebalancing, and still keep up with inflation.

 

[Fedup]

That 2008 reflection also describes me.

That's why I wonder if I'll have the guts to continue to rebalance to target when the next crash happens. My protection from having to liquidate equities comes in the form of a 401k guaranteed income fund, and it would last me a somewhat long bear market if I rebalanced, and a very long bear market if I didn't.

You are not alone, I wash in cash, got lots in cash and I didn’t buy in at the low. I wish I found this forum earlier. I was moving my cash from one bank to another. My first bank run experience and hope that to be the last.

 

[UnrealizedPotential]

But we individuals don’t have to have ALL our assets in equities to beat inflation. It can be less than 50% with rebalancing, and still keep up with inflation.

I realize that. I'm at 56% stocks and I feel comfortable keeping up with inflation. As far as rebalancing goes, I have no opinion one way or the other. As long as my AA is set and I can sleep at night and I feel comfortable no matter what happens, I don't worry about it.

 

[Fedup]

Except for my pension which is non-COLA, the rest of my income do keep up with inflation. Technically I could be 100% in stocks but I’m not greedy, my kids were told to work for their money while I spend their inheritance.

 

[Jollyquick]

TANSTAAFL; if the return is similar then the quality and risk are higher.

Mr. Heinlein and Mr. Friedman are smiling somewhere

 

[Jollyquick]

Greetings,

Depending on what you read and/or choose to believe, your average bear market recovers in about a year. 367 days according to this recent article:
https://www.thebalance.com/u-s-stock-bear-markets-and-their-subsequent-recoveries-2388520

I use a very simple bucket rule, if 1 x annual expense - liquidity (“cash”) > zero then reinvest. If 1 x annual expense - liquidity < zero then rebalance or reallocate.

I’ve used this rule since I first started investing in the 1980s and it has worked for me through all the big bad bears since Black Monday. For me, a years worth of liquidity gives me peace of mind and the ability to flex financially to take advantage of opportunity or weather out a storm. The time value and opportunity cost is minimal compared to the peace of mind it provides me.

So in the end a cash buffer is really a personal choice that will be different for everyone based on their risk threshold and financial situation.

 

[FinancialDave]

There are quite a few studies which show a cash buffer hurts an investor.

To my knowledge there are no studies which concluded a cash buffer did one any good except psychologically.

We don't keep any more cash around than enough to pay the next month's bills.

Let me say the bold text in a different way that puts the correct "spin" on it - IMHO:

Since most money that is lost in a down market (and it can be substantial) is due to what could be called "psychological" reasons it only makes good sense to have a 2-4 year cash buffer to last through most bear markets.

In other words "studies" are great but they don't mimic the real world IMO. In the real world "most" (but not necessarily all) cannot stand by and see their portfolio lose 50% of its value and then need to sell stocks or bonds at a loss just to pay the bills. If you were spending 5% of your portfolio before the crash you are now spending 10% of your portfolio and that is not money you will get back.


By the way there is a book written by the Founder of AAII called "investing at Level 3" which explains how the cash account can work to your benefit in retirement and how it can be done while controlling "real risk" as opposed to the "ghost risk" of short-term volatility.

 

[indiajust]

Buffett can afford to do that. He can afford to hold large amounts of cash and play the waiting game for years. Most of us need to put our money to work now to support ourselves and reap the stock market gains to keep up with inflation.


I hold some cash, but using it to buy up bargains left and right if a bear market hits is a pipe dream. But yes, I agree with you in that there is a ton of money to be made if one can hold cash and wait for bargains. I just think for the most part, the average investor may not be able to do that on a large enough scale to make much difference to their net worth.

It is my pipe dream. And generally part of value investing. In order to buy low, you suffer the opportunity cost of low cash yields during the good times and bide your time. Buying at a low PE or PS while the market is tanked and being willing to wait is a brutal game, but a sure thing. It does not take many home runs like that to radically boost a portfolio lifetime yield. You are close to a Chuck Prince phrase:
"When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you've got to get up and dance. We're still dancing."
Chuck Prince, July 10th, 2007 (Former Citigroup CEO)


Momentum investing works too, or you can just buy sectors that are temporarily out of favor in the hope that they bounce back, rather than wait for the entire mkt to tank.

 

[Fedup]

Momentum investing works too, or you can just buy sectors that are temporarily out of favor in the hope that they bounce back, rather than wait for the entire mkt to tank.

I thought that’s value investing. Momentum investing is buy high and sell higher like jump on bandwagon because you are riding up. It works the same as when a stock goes down like when sharks smell blood in water, you short the stock. The emotion when the stock goes up or down works the same. Over swing either way.